Stock Lending Today - An Industry Under Siege!

AIG and Barclays

Two bits of important company news today.

AIG

There has been a HUGE amount of press coverage yesterday and today since AIG disclosed recipients of payments after the US government bailout last year.  Some $43 billion was moved to securities lending counterparties to satisfy collateral obligations.  The outrage has been stoked by various media reports suggesting that somehow these payments were inappropriate.  I have even read stories where reporters were railing against the fact that some of these collateral payments were made to “foreign” (meaning “non-US”) banks like Barclays, Deutsche Bank and BNP Paribas (the three biggest disclosed recipients).  You can see the list here.

I guess all of those reporters and commentators would rather have had AIG go into default and the bailout money going to lawyers rather than to continue to support AIG’s ongoing operations.  I assumed that the idea of the bailout was to assist AIG in carrying on its business.  Silly me.

Barclays

Barclays has been working hard for months to try and ensure it avoids UK government money.  My guess is that they feel that once a bank is beholding to the government, things change, and they aren’t necessarily good changes.  (As far as I am concerned, other than protecting depositors’ cash, I can’t see any useful government ownership of the banking business.)

This weekend and through today it has been reported that Barclays was in discussions regarding the possible sale of its ETF business – iShares.  The possible sale proceeds have been quoted as anywhere between £3 and £6 billion.  iShares is the leading brand name in the business and ETFs as a product continue to grow in importance as a path to investment for institutions and retail investors alike.

ETFs are also ideal from a securities lending point of view, and iShares is a key part of the Barclays Global Investors lending programme.  If Barclays sells iShares, what will the impact be for BGI’s lending?  Don’t underestimate the importance of iShares to their programme, but BGI was a top tier lender before the dramatic growth of the iShares franchise, and there is no reason to think that would change without it.  In any case, no doubt part of the discussion would involve BGI continuing a third party lending relationship for any buyer.

P.S. Spitalfields Forum tomorrow, so don’t know if I will be posting, but you can follow Len Welter who will be Twittering the conference.  And maybe I’ll throw in a comment or two of my own! 

Stop Short Selling Now!

I came across yet another blogger demanding a ban on short selling.  I suppose it's inevitable when you see the markets crashing towards a Dow 6,000 level. And you see more government money going into AIG and then are astounded by Eton Park's profit from their HSBC short position of somewhere between £140 and £160 mm.

However, in an attempt to get US retail investors riled up he uses Apple as his example and alleges that poor unwitting retail punters' shares are being used by dastardly short sellers to drive down the price of the stock.  I spend a lot of time responding to blogs like this.  (OK, maybe I have too much time on my hands)

I pointed out that AAPL short interest peaked (from a  reporting point of view) on Oct 31 with 28 mm shares sold short.  The closing price that day was $107.59.  As of the most recent reporting date Feb 13, only 19 mm shares were short.  The price closed that day at $99.16.  Short sellers were net buyers of 9 mm shares during that period and yet the price still declined.  That tells me it is long investors selling more than new long investors were interested in buying.  It doesn't say that short sellers were driving it down and the fact that it is less than one day's average trading volume means that it has minimal impact overall in any case. 

I also noted that more high profile stocks like Citi, Bank of America and JPM all had short interest less than one day's trading volume.  I think companies and investors should spend less time trying to deflect blame on to short sellers and instead focus on sorting out their fundamentals.  As of the time I am writing this blog, my comment still hasn't been published.  The hit rate for my comments is about 50%, so we'll see how confident the writer is in his argument.  Changing the perception on short selling, one blog at a time!

Head for the hills - or at least the fields!

If you are employed in the financial industry, and are based in London or New York, you have probably had a pretty tough time.  If you are a little down about it, DON’T watch the video this morning from CNBC Asia which features Jim Rogers.  Jim suggests that Wall Street and its brethren around the financial world are headed for a difficult decade and tells us that farming is the future.

Jim’s suggestion that NY will suffer badly is backed by CDS spreads on NY City as covered by this article from Tyler Burden at Zero Hedge.

In the Press

Finally, I had an article published yesterday in the current issue of Securities Industry News entitled “Crisis Puts SecLending Risk Practices to the Test”.  I like the magazine, and Chris Kentouris, Senior International Editor, is possibly the nicest journalist in the business.

State Street Earnings Jump! (UPDATED STORY)

Someone was saying the other day that for the first time in years there was a risk of being underweight in Equities … Hmmm.  How high can your dead cat bounce?  (Not very!)

Another day,  another part-nationalisation – in this case the Swiss get involved.  It's a good thing the Swiss government doesn't need to hedge these convertible bonds.

State Street had a Q3 earnings call yesterday

I have included below some interesting comments from the Bloomberg report, and some excerpts I have chosen from the SeekingAlpha.com transcript of the call.

Bloomberg:  Securities-finance fees jumped 49 percent to $246 million and asset-management fees declined 13 percent to $266 million.

SeekingAlpha.com Ron Logue, State Street Chairman and CEO:  "None of our funds that support State Street Securities lending business has lost money for our customers. Due primarily to declines in the market, but also suspension or reductions in securities lending by some customers, we have seen assets in our lending program decline by approximately 20%. As a result, we have seen increased withdrawal activity from the collateral pools, but we have been able to manage these outflows in a manner that protects our customers from loss.  The current spreads and volatility are expected to at least partially offset the impact of lower volumes."

There is a clear conflict with the Bloomberg story quoting a Moodys report as saying “Investors are also pulling out of securities-lending programs because of losses by short-term debt funds their collateral is invested in” and the statement by Ron Logue.

My main concern all year has been the potential negative impact on the securities lending business as a result of cash reinvestment losses.  This is the area where the most public losses associated with securities lending have occurred and generated considerable negative sentiment. 

We should be cheered and relieved by State Street’s comments, but I still have a general feeling of discomfort for the wider universe.  Must be the dodgy hot dogs I ate at the Heat/Nets basketball game the other night.

UPDATE:  Thanks to the intrepid reader that spent their time reading State Street's Form 8-K Filing.  There are a number of fascinating comments in the document, and let me point out a couple of them to you:

"For clients that invest directly or indirectly in certain of the collateral pools and seek to terminate participation in lending programs, we have required, in accordance with the applicable client arrangements, that these withdrawals from the collateral pools take the form of in-kind distributions of securities."

"In addition to the impact on the market value of client portfolios, the illiquidity and volatility of both the global fixed-income and equity markets have negatively affected the ability of SSgA to manage client inflows and outflows from other pooled investment vehicles."

That's the kind of thing that worries me.  It also adds some clarity to the letter State Street issued to clients last week.

City Job Losses

I don't even want to talk about jobs however, this too is reality.  Here is the City "If You Think This Year's Bad For Job Cuts, Wait 'Til 2009" .  As usual the Uri Geller of Hedge Fund prognostications, Finbar Taggitt was pretty darn accurate in his guess from over a year ago.   Did I say Uri Geller?  Sorry Finbar, better than that, much better!

 

Securities Lending Counterparty Risk: Tipping the Scales

Everyone is thinking about how the world has changed in recent weeks and the implications for their business.  I'm a sheep, so I'm wondering about that as well. 

One of the most important and obvious issues for securities lending is that of counterparty risk.  I have always argued that this is the single most important risk issue. I make this statement on the basis that if the borrower is still in business, you can always get more collateral.  However, if the borrower if bust, you are burned.  It doesn't matter if you have the highest quality collateral or how much haircut you have taken.  If the shop door is open, you can deal with any issues.  If the sign says "Closed", you might be out of luck.  The highest priority that everyone has had over the past month is sorting out the aftermath of the Lehman failure. No one in the business has wanted to go through the past month of turmoil.  Even if lenders had enough money left over after liquidating their collateral to repurchase the securities on loan to Lehman, the stress during the period was tremendous and people just don't want to have that happen again.

So where are we now?  The big three prime brokers from January 2008 - Morgan, Goldman and Bear - are now banks (or part of banks).   These banks are now part of a bigger group of semi-nationalised or completely nationalised banks that are active securities lending market participants.  What does this do to the counterparty credit assessment process.  I had dinner yesterday with someone who's view is that essentially counterparty credit risk is no longer a concern for those quasi-government entities.  I don't necessarily agree with that point (in fact I don't agree with it at all), but there is no question that the credit department will view those firms differently today than they did last Wednesday. 

And what will the impact be for those firms that haven't had government money pumped into them or refused the offer of money?  There has been a lot of debate in the UK about Northern Rock competing unfairly with other British banks.  However, that will be easy to monitor in retail interest rate offers and mortgage deals.  Many people will continue to follow this. 

But in our securities lending universe two things seem certain:

• If market participants see an advantage they can seize - they will;  AND

• There is no clear way for anyone to monitor any potential abuse of market position. 

General comments on the investment markets:

Tuesday's Slip Hardly Fatal (don't worry we are at or near the bottom);

Friday's market was definitely the low (very brave prognostication);

From the interesting world of the Day Trader - Timothy Sykes article

The New Reality is Clearly ...

... well, unclear.

Who could have foreseen at the start of 2008 that we would be here today.  Being an overachieving Goldman alumnus, Hank Paulson clearly wanted to run more than just Goldman, so his master plan turns out to be that he wanted to run the entire US banking industry!

The world of Prime Brokerage is a very different one.  We started the year with Morgan, Goldman and Bear the dominant players.  Bear has been swallowed up by JP Morgan and the uncertainty amongst hedge funds caused by the failure of Lehman has had a well-reported knock on impact on the other prime brokers.  Fitch Ratings has recently made the following comment on Morgan Stanley's outlook: 

"Customers are migrating away from its premier prime brokerage business due to deleveraging and concerns around the protection of client assets." 

While to an extent this is MS specific, it is also a comment on the concerns and issues facing the PB industry as a whole. 

It will be critically important to see how the new world of government intervention in the banking community sits with the business of service provision to hedge funds.  Time will tell how much control and influence the US, UK and other governments will exert on the specific business lines of their partially, or completely  nationalised banks.  How will it sit with the average American now that the US government has an ownership stake in firms that provide leverage and services to hedgies?  This is the very industry comprised of evil short sellers that many in the media, corporate America, and even the financial industry have blamed for the crisis in the first instance?  Strange bedfellows indeed! 

Further, what opportunities will arise for the banks that don't have government interference ruling their lives?  Many of the European banks anecdotally have been winners of PB mandates over the past year.  Will that continue, accelerate or level off?  I have my views, what are yours?

N.B.  Jim Chanos reports in this Bloomberg Video that "We have the least amount of financials short in our portfolio that we've had in four years ... our view is the risk-reward is not great on the short side ... We're looking elsewhere"  This expert opinion reinforces my previous comments that more opportunities exist in rising markets than in falling ones.